Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Epiroc AB (publ) (STO:EPI A) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Epiroc Carry?
You can click the graphic below for the historical numbers, but it shows that as of December 2020 Epiroc had kr8.12b of debt, an increase on kr6.40b, over one year. However, it does have kr15.7b in cash offsetting this, leading to net cash of kr7.61b.
How Healthy Is Epiroc's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Epiroc had liabilities of kr8.87b due within 12 months and liabilities of kr11.3b due beyond that. Offsetting these obligations, it had cash of kr15.7b as well as receivables valued at kr7.65b due within 12 months. So it can boast kr3.24b more liquid assets than total liabilities.
This state of affairs indicates that Epiroc's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the kr208.7b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Epiroc boasts net cash, so it's fair to say it does not have a heavy debt load!
On the other hand, Epiroc's EBIT dived 10%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Epiroc's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Epiroc may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Epiroc produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company's debt, in this case Epiroc has kr7.61b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 72% of that EBIT to free cash flow, bringing in kr7.3b. So we are not troubled with Epiroc's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Epiroc .
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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